ovements in relative prices play a large role in economic fluctuations, particularly in emerging economies. Sudden stops in capital movements, for instance, are typically associated with sharp depreciations of the real exchange rate, which in turn can wreak havoc with private sector balance sheets. This raises the question of what is behind these real exchange rate fluctuations-whether it is the relative prices of traded goods that move, or the price of nontradables in terms of tradables. Answering this empirical question is crucial both for building relevant models and for designing policies to moderate the dramatic macroeconomic fluctuations that seem to plague emerging economies.The dominant view in the empirical literature on real exchange rates is that exchange-rate-adjusted relative prices of tradable goods account for most of the observed high variability of consumer-price-index-based real exchange rates. 1 Based on an application of his earlier variance analysis to Mexican data, Engel concludes that this dominant view applies to Mexico. 2 Using a sample of monthly data from 1991 to 1999, he finds that the fraction of the variance of the peso-dollar real exchange rate accounted for by the variance